Europe needs to stop the insanity

Michael A. Gayed, CFA, winner of the 2014 Dow Award, is chief investment strategist and co-portfolio
manager at
Pension Partners, LLC., an
investment advisor which manages mutual funds and separate accounts according
to its ATAC (Accelerated Time and Capital) strategies focused on inflation
rotation. Prior to this role,
Gayed served as a portfolio manager for a large international investment group,
trading long/short investment ideas in an effort to capture excess returns. From
2004 to 2008, Gayed was a strategist at AmeriCap Advisers LLC, a registered
investment advisory firm that managed equity portfolios for large institutional
clients. In 2007, he launched his own long/short hedge fund,
using various trading strategies focused on taking advantage of stock market
anomalies. Follow him on Twitter @pensionpartners and YouTube
youtube.com/pensionpartners.

While everyone is focused on the Dow Jones Industrials Average hitting the 17,000 level and the S&P 500 crossing 2000, the real thing to think about is the madness of the crowd. It is now a foregone conclusion by market pundits that the European Central Bank (ECB) will initiate quantitative easing (QE). The argument? Germany and Italy are contracting, and bond yields in all developed market are signaling deflation.

I don't disagree — Mario Draghi may indeed do some form of QE given that the hardest thing to do for any central bank is to do nothing at all. But can we all take a step back for a moment and think about just how insane this line of thinking is? Last I checked, quantitative easing has failed to do anything meaningful to Japan's gross domestic product (GDP) and inflation from the standpoint of wages. Last I checked, quantitative easing has failed to significantly boost U.S. GDP and inflation expectations, though it has greatly widened the gap between rich and poor.

"Insanity: Doing the same thing over and over again and expecting different results."

When can we finally step away from the trading screen and think for a moment about where we are in the growth and inflation expectations cycle for the economy which the stock market is supposed to be a discounting mechanism of? Shouldn't some sectors of the stock market provide clear and unambiguous lead/lag characteristics which would allow sector-rotation funds, like our ATAC Beta Rotation Fund
BROTX, -3.95%
the chance to be able to generate alpha from?

Perhaps none of this matters. In a world where you've hit the zero point on interest rates, bond buying is the only thing a central bank really can do. Stocks, as a result, seem to love it, with buy-and-hold investing back in full force. But what if we are nearing the point where no amount of stimulus coming from the European Central Bank can save Europe from Japan's fate?

If we assume that Europe is heading in that direction, the only trick left in the hat is to break the euro in the way that the Bank of Japan broke the yen in 2013.

Take a look below at the CurrencyShares Euro ETF
FXE, -0.63%
and note the downtrend that is in place and could persist in the current price of this Exchange Traded Fund. This chart shows a clear downtrend in the euro, which in turn means a strengthening dollar.

Everyone thinks QE in Europe would be bullish, but if the euro breaks down further and causes a significant rise in the U.S. dollar, would that not be an additional disinflationary force, given that whenever the dollar appreciates, it makes foreign-imported goods less expensive and puts downward pressure on all prices?

Indeed, Europe may be the biggest threat to the U.S. stock market, but it may not be because of the economies of the euro zone. It may be because of the insane belief that QE will work, what that means for the euro/dollar, and what could be the final realization that central bank policies are failing.

Badger on.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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